Understanding the Market

On December 1, 2008, the NBER announced that a recession in the US started in December 2007 (for more about how the NBER came to this conclusion, see here; for the NBER announcement, see here). [Note that after this article was initially posted, the data have been updated and the table includes updates; see below for details.]

The NBER described the five monthly series which they have followed, (1) payroll employment, (2) real personal income less transfer payments, (3) real manufacturing and wholesale-retail trade sales, (4) industrial production, and (5) employment estimates based on the household survey.  This last measure is not included in their prior research

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, but generally is similar to the payroll employment number.

Here are these data expressed as a percentage of December 2007 values, the date that the NBER denoted the peak of the previous business cycle.

Source: Department of Commerce, Bureau of Labor Statistics, Federal Reserve Board and author’s calculations; all data expressed as percentage of December 2007 values.

———————————

The NBER defines a recession as a significant decline in economic activity spread across the economy, lasting more than a few months, and these data indicate the economy is in recession.  All five indicators have been in decline for more than a few months

, with their peaks coming between September 2007 (real Personal Income) and April 2008 (household employment).

Now that we know that a recession has started, the question is when the recession will end.  I will continue to update this table with current data; as of the most recent data (November 2008), the recession continues.

[Update Dec 25 2008] Just before Christmas

, the BEA released November personal income data that were up sharply (largely due to the drop in prices) almost to the level at the start of the recession; October sales data were also up.  But personal income also remained stronger than the other economic measures during the 2001 recession and sales remain well below the peak level.

[Update Jan 11 2009] Employment data are still very weak; a benchmark revision to the household employment number is now presenting a similar picture to the payroll data.

[Update Feb 1 2009] Sales and Industrial production continue to fall; personal income is steady, not much below the level at the start of the recession, but this measure did not track other variables during the 2001 recession either.  One wonders why the NBER still include personal income in their analysis.

[Update Feb 12 2009] Employment continued to fall in January; further, a benchmark revision of the payroll employment data make the payroll job loss steeper than it had been.  The BLS does not revise the previous household numbers, but the sharp drop in the household number between December 2008 and January 2009 is in part due to the revision (see here for more).

[Update Feb 19 2009] Industrial production continues to decline.

[Update March 2 2009] PI was revised higher but the latest numbers are down; sales continue to decline.

[Update March 8 2009] Continued weak employment numbers with a slight downward revision for the payroll data.

[Update March 16 2009] Continuing weak industrial production with a slight downward revision.

[Update April 1 2009] Continuing weak personal income and sales data.

{Update April 3 2009] Continuing weak jobs data

[Update April 16 2009] Annual revision of industrial production is mostly negative; IP is revised down for most of the last 18 months and now has a peak coincident with the recession.

[Update May 4 2009] Personal income continues to decline; real sales had a modest rise in February but remains at a low level.

[Update May 8 2009] Payroll employment continues to decline but household employment turns up slightly.

[Update May 15 2009] Continuing weakness in industrial production.

[Update June 7 2009] Little sign of any improvement; perhaps the rate of decrease is slowing

, but no evidence of improvement in sales or employment.  Personal income is up a bit, but largely due to increased  payments by the government.

[Update June 16 2009] Continuing weakness in industrial production

[Update June 30 2009] Personal income remains weak; the increase in the headline number was caused by the increase in transfer payments which the NBER number subtract from the total.  Sales are also weak.

[Update July 2 2009] Another weak employment report, with both household and payroll numbers weaker.

[Update August 4 2009] Personal income numbers have been revised greatly changing the behavior of this series see here for details.  Revisions were largely negative.  IP is still weak; sales data will be revised in the next few days.

[Update August 14 2009] The sales data have been completely revised showing a modestly more serious decline during the recession period.

[Update August 28 2009] Both Industrial Production and Personal income are up in July (positive data will be indicated in bold); this is perhaps a preliminary indication of the end of the recession.  The NBER will wait to make a declaration that the recession is over until the evidence is much clearer.  Sales data were weaker in June.

[Update September 4 2009] Employment continued to decline in August at a slower rate.

[Update October 12 2009] BEA now calculates Personal Income minus Transfers and I am using their series that is very similar to the series I calculated; modestly down in August.  Household employment dropped sharply in September and is now just about where payroll employment is.  Industrial production was up again in August (indicative of the end of the recession).  Sales were up in August

, another indicator that the recession may have ended this summer.

[Update December 29 2009] Personal Income

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, Industrial Production and Sales are all modestly up from their early summer minima.  The drop in payroll employment is close to zero, and household employment turned up in November.  All evidence seems to confirm that the recession ended in the summer of 2009, but the NBER is unlikely to declare an end until there has been a substantial increase in employment.

To combat the economic slowdown and credit crisis of 2007-2009, the Fed took actions that were beyond anything attempted in the last 50 years; interest rates were cut to virtually zero and the Fed massively expanded its balance sheet by purchasing (in addition to the usual Treasury Bills) Treasury Bonds and Mortgage Backed Securities from Fannie Mae and Freddie Mac.  In another article I briefly described the policy actions the Fed has taken.  This article discusses (and tracks) the possible inflationary consequences of the Fed’s actions.

Many economists believe there is an approximate relation between changes in the money supply and changes in the price level i.e.

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, inflation  (see, among many others here and here).  While the relation between money and inflation is not precise

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, few economists believe that large increases in the money supply will not eventually lead to large increases in prices.

Many economists are not worried about this relation in the short run, as they believe that while the economy is below full capacity (when output is below the maximum that the economy could produce or when unemployment is greater than normal) that monetary expansion will not result in inflation.  But as the economy recovers and output and employment recover, inflation is likely to accelerate.

So, when the economy recovers (assuming that the US will not face an extended crisis like the 1930s) the Fed will have to figure out how to undo the monetary expansion. Fed Vice Chairman Donald Kohn recently summarized the problem:

…the Federal Reserve’s actions to ease credit conditions have resulted in a tremendous increase in its assets and in bank reserves.  Some observers have expressed concern that these actions, if not reversed in a timely manner, are sowing the seeds of a sharp pickup in inflation down the road.  As I just noted, near-term prospects appear to be for a decline in inflation rather than an increase.  But my colleagues and I are acutely aware of the risk of higher inflation as the economic recovery gains speed.  We are firmly committed to acting in a way that preserves price stability

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, and we believe we have the tools to absorb reserves and raise interest rates when needed.  Moreover, we are working with the Treasury to introduce legislation that would enlarge our tool kit for moving away from the extraordinary degree of financial stimulus we have put in place when the time arrives.

This page will track some of the key variables associated with the possible inflationary surge. First, I will characterize the state of the economy, calculating how close production is to capacity.  Second, I will track several measures of the policy actions taken by the Fed and finally I will present several measures of inflation.

Source: Bureau of Economic Analysis and author’s calculations.  I assumed that the economy was at potential at 2007IV and that potential GDP grows at 0.75% per quarter (roughly 3% per year).

Source: Federal Reserve Board; Monetary Base (SA) and M2 (SA) expressed as percentage of December 2007 levels. Fed Funds represent end of month values; on December 16

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, 2008 the FOMC announced that the target rate for Fed Funds was 0 to 1/4 percent.

Source: Bureau of Labor Statistics;

So what do we see in these data?  From the first panel

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, the economy as I write (May 2009) is 6% below full capacity.  From the second panel, starting in September 2008 (after the failure of Lehman) the Fed began a major balance sheet expansion, doubling the monetary base in roughly three months as the Fed purchased assets to try to ease the problems in credit markets.  The expansion of the base has only resulted in moderate expansion of broad money and in the third panel we can see that it has had little effect

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, so far, on inflation.  The Fed has a difficult job ahead, and I will track its progress by updating these tables in coming months.

[update June 18 2009 Monetary expansion continues in May, but there is still little evidence of inflation]

[update July 15 2009 the Monetary base declines significantly]

[Update August 14 2009 some evidence of modest monetary contraction in July with little evidence of inflation]

[Update September 26 2009 inflation up as gas prices rise but core fairly stable, monetary base up but M2 contracts]

[Update December 29 2009 The output gap continues to widen (growth in the third quarter below potential), with monetary expansion continuing and a bit more inflation]